Financial Product Pricing System

ABSTRACT

The invention relates to a financial pricing system. More specifically, the invention relates to a system consisting of interface means for inputting data which identify and describe the aforementioned product, and data-processing means which are used to generate the following elements from said identification and description data: (i) a planned schedule (T1) in which an event and/or flow relating to the product is associated with each date; (ii) a table of variables (T3) for the product from the aforementioned events and/or flows; and (iii), for each date of the planned schedule, a calculation of the product price according to at least one of the aforementioned product variables. The inventive system also comprises interface means for inputting a list of market variables (T4) which are associated with the product and which are generated by a market analysis. The invention further comprises means of calculating the product variable values according to the market variables and the product price according to the calculated product varaiable values.

The invention concerns a financial product pricing system.

Financial products, and in particular derivative products, are subjectto very strict regulation that requires financial establishments andcommercial enterprises using them to price them as a function of acertain number of hypotheses, involving variables arising from thecharacteristics of the products in question and variables arising fromthe financial markets to which these products belong. These prices mustbe calculated for the purposes of valuation and also so that they can beincorporated into the required Financial Risk reports, in particular theVaR (Value at Risk). These “pricing” calculations must be updated veryfrequently—usually daily—which involves very cumbersome data processing.

In addition, many new financial products appear regularly. The analysisof each new product in order to calculate the price, the VaR, etc., isvery cumbersome work, and most often requires developing a specificpricing model. This model is then integrated into the informationprocessing systems used for the examination, processing, valuation, andcalculation of risks. These systems are often different.

The invention aims to provide a system that makes it possible tosimplify considerably the operations involved in pricing a financialproduct.

For this purpose, the object of the invention is a financial productpricing system consisting of interface means, data storage means,calculation means, and data processing means, a system that isremarkable in that:

(a) the interface means consist of means for inputting data thatidentify and describe the product into the system, whereby these dataconsist of:

-   -   (a1) contextual data of the product, consisting of at least one        valuation currency and at least one underlying instrument,    -   (a2) characteristic data of the product, consisting of a set of        events and flows associated with the product;

(b) the data processing means consist of means for generating a plannedschedule from the identification and description data, in which an eventand/or flow relating to the product is associated with each date;

(c) the data processing means also include means for interpreting theschedule, in order to generate:

-   -   (c1) a table of variables for the product on the basis of the        events and/or flows,    -   (c2) for each date of the planned schedule, a function for        calculating the product price as a function of at least one of        the product variables;

(d) the interface means consist of means for inputting a list of marketvariables associated with the product and generated by a marketanalysis; and

(e) the calculation means consist of means for calculating, for each ofthe market scenarios/states and for each of the dates, the productvariable values according to the market variables, and means forcalculating the product price as a function of the calculated productvariable values.

According to one embodiment, the data processing means consist of meansfor generating a compact script containing all the data needed forproduct pricing.

According to another embodiment, the means for inputting dataidentifying and describing the product consist of means for inputtingthese data in compact script form.

According to another embodiment, the means for inputting dataidentifying and describing the product consist of acquisition windows,into which the contextual data and characteristic data can be enteredseparately.

According to another characteristic of the invention, the dataprocessing means also include means for checking the interpretation ofthe schedule.

According to yet another characteristic of the invention, thecalculation means consist of:

-   -   (e1) means for calculating, for each of the market        scenarios/states and for each of the dates, the value of each of        the market variables,    -   (e2) means for calculating, for each of the market        scenarios/states and for each of the dates, the product variable        values as a function of the market variable values,    -   (e3) means for calculating the price as a function of the        product variable values in all the market scenarios/states.

Other characteristics and advantages of the invention will becomeevident from the following description of an embodiment of theinvention, illustrated by the attached drawings, in which:

FIG. 1 is a functional block diagram illustrating the basic means usedby the system according to the invention to describe a financial productand to price it;

FIG. 2 is a functional block diagram illustrating the means and dataneeded to price a financial product by the system according to theinvention;

FIG. 3 is a functional block diagram illustrating the process forpricing a financial product using the system according to the invention;

FIGS. 4 and 5 are tables illustrating the storage means needed for thepricing process of FIG. 3;

FIGS. 6 to 8 illustrate the computer acquisition windows for theinformation needed to describe a financial product according to theinvention.

Referring to FIG. 1, pricing a financial product using the systemaccording to the invention involves the following data and means:

-   -   a calculation tool called a pricer 1;    -   product variables 2 that are a function of the nature of the        financial product in question (for example, swap, call, etc.);    -   market hypotheses 3 known to financial specialists (for example,        normal, log-normal, mean reverting, multifactor, etc.) that        depend, among other things, on the underlying instrument 4 (for        example, share, bond, exchange rate, credit, etc.) attached to        the product in question; these market hypotheses make it        possible to determine the various market scenarios or states and        the way in which these scenarios will be generated and modeled,        whereby each scenario corresponds to a set of possible market        variable values, a set that is used to price the financial        product;    -   calculation means consisting of numerical resolution methods        known to financial specialists (for example, trees 6,        integration 7, partial differential equations or PDE 8, the        Monte Carlo method 9, etc.), which make it possible to price the        product on the basis of the product variables and market        hypotheses.

According to FIG. 2, the system making it possible for a user to price afinancial product first involves a description of the product. Thisfirst of all requires acquisition of the following, thanks to the systeminterface means:

-   -   contextual data of the product, that is, at least one valuation        currency (making it possible to define all the conventions of        the market or the place in question) and one or more underlying        instruments (for example, rate curve, “share”, exchange rate,        etc.), that is, the market quantities used to define the        product; these contextual data indicate what market variables        will be involved in the product pricing and used for selecting        market hypotheses;    -   characteristic data of the financial product in question. These        data consist of a schedule of events and flows associated with        the product.

For this purpose, the user may either:

-   -   input a compact script 10 of the type shown in FIG. 8, which        contains all the information (contextual data and characteristic        data of the product) and will then be separated into different        objects, each containing these two types of data, or    -   input directly into separate windows the product contextual data        on the one hand and characteristic data on the other, as        illustrated by the acquisition screen in FIG. 6.

On the basis of these data describing and identifying the product, thedata processing means of the system are used to generate a plannedschedule at 13, that is, an exhaustive series of dates D1, D2 . . . Dn,with an event and/or a flow relating to the product associated with eachone (Table T1).

A table of objects T2 and a table of product variables T3 areconstructed at 14 and 15, respectively, by means of a “parser”.

Table T2 is an intermediate table that makes it possible to define andconstruct, for each date in question D1, D2 . . . Dn, one or moreevaluation trees representing a tree form of the function Y₁=f(t, x₁ . .. x_(n), Y_(t-1)), in which:

-   -   Y₁ represents the current value of the product variable or        variables;    -   t represents time;    -   x₁ . . . x_(n) represents the value of the market variables that        will be identified at 17.

Table T3 is a list of product variables and the values associated witheach of these variables, values that are updated by the evolution treeor trees of Table T2.

At 16 the system uses verification means to make sure of the consistencyof the data of Table T2.

At 17, a market analysis is done in order to construct an objects table,“world” (T4). This table consists of a list of additional marketinformation that is needed at each of the dates D1 to Dn to price orevaluate the product.

These “world” objects are defined on the basis of a number of basicelements, four of which are especially important:

-   -   the spot (shares, raw materials, energy, indexes, etc.);    -   the exchange rate;    -   the interest rate, preferably represented by discount factors.        This can also be zero-coupon rates, the Libor rate, a swap,        etc.;    -   information on counterparty default; for example, has a bond        defaulted? This may also involve a rate “spread” representing        the credit risk.

Since the market variables at this stage are identified and Table T4 isconstructed, construction of the evaluation trees of Table T2 istherefore achieved.

On the basis of the data obtained as described with reference to FIG. 2,the “pricer” 1 proceeds to calculate the price by applying one of thenumerical resolution methods 5.

These financial numerical resolution methods (for example, trees 6,integration 7, partial differential equations or PDE 8, the Monte Carlomethod 9, etc.), which are standard and well known to financespecialists, achieve the following:

-   -   simulate or explore possible values of market variables;    -   calculate the desired or future value of product variables.

The functional block diagram in FIG. 3 illustrates the numericalresolution of the product pricing problem. At 20, depending on thenumerical resolution method 5 in question, acquisition of the contextualdata used in the method (which have been obtained as described withreference to FIG. 2) and of the number of product variables is carriedout.

At 21, numerical resolution means generate the values of the marketvariables at each date D1, D2 . . . Dn of the schedule according to themarket hypotheses in question, as well as at each scenario establishedas a function of these hypotheses. As shown in FIG. 4, a table of marketvariable values Tvvm corresponds to each date and market scenario/state.

At 22, the numerical resolution means calculate the product variablevalues for each date and market scenario/state in question. As shown inFIG. 5, a table of product variable values Tvp corresponds to each dateand market scenario/state in question.

At 23, the numerical resolution means finally produces a product priceas a function of the set of calculated product variable values.

An example of implementing the mechanisms making it possible to identifyand describe a financial product by its contextual data and itscharacteristic data as indicated at 10 and 12, in order to constructTable T1 in FIG. 2, will now be described in greater detail withreference to FIGS. 6 to 8, which represent acquisition windows of theproduct to be described.

These mechanisms make it possible to describe any structured financialproduct, independently of its underlying instrument or the structure orcharacteristics of its flows. These mechanisms have:

-   -   a syntax defining the type of phrase structure accepted and        compressed;    -   a dictionary of predefined words that are “compressed”;    -   the capacity to accept new words if they are suitably defined        and introduced.

In the example that follows, a convertible bond will be defined. First,the market variables in question, that is, the currency and its “rate”curve and the pertinent “transferable security”, in this case the DAX,are introduced into the windows 30 and 31 of FIG. 6.

It is necessary to describe the sum that the bond will pay at maturityif it is not converted. For this purpose, the term “Redempt” isintroduced at 32, to designate the amount paid back at maturity. Anumerical value is assigned to it at 33, in this case 100.

Likewise, “Coupon” and “ConvPrice” are introduced at 34 and 35, andtheir respective numerical values at 36 and 37.

In order to suitably define the product, the idea of “conversion ratio”must be introduced. This is done at 38 by indicating that“Conv_Ratio(x)” is equal to “100*(x)/ConvPrice” (window 39).

Then we must describe the product, that is, the flows that it willgenerate and the conditions of this generation if necessary.

In the hypothesis in question, the convertible bond pays a coupon(window (43) from any point of departure (window 40), at an annualfrequency (window 42) for five years (window 41).

At the end of five years (window 44), the bond pays its redemption value(window 45).

The bond's conversion characteristic is expressed by the fact that atany time (“Od”, window 46) during the five years (window 47), the valueof the product is the maximum of the product value and its conversionratio (window 48):

Convert=max(convert,Conv_Ratio(dax)).

These mechanisms also make it possible to very simply describe aconvertible bond with particularly unusual characteristics.

Thanks to the interface means, shown in FIG. 7, the system according tothe invention generates and can then display the product flows based onthe data introduced in the form of a preestablished format. This allowsthe user to make sure that the discounted flows are properly representedand captured by the system.

Finally, the data processing means make it possible for the system togenerate a script (FIG. 8), that is, a code precisely describing theproduct characteristics and containing all the information necessary forpricing the product. The script, show in FIG. 8, can be exchanged amongall the intervening parties to describe and price the product.

As a variant, all the information, that is, the contextual data and thecharacteristic data of the product in question, can be acquired by auser in the form of a compact script of the type shown in FIG. 8, whichcan then be broken down into different objects, each containing theproduct's contextual data and characteristic data.

Describing the product using windows, leading to the generation of ascript that can be exchanged among and interpreted by differentcomputers as described above, or directly in the form of a script,requires the user to use predefined words that are part of a dictionarythat can be expanded, if necessary, and a syntax defining the type ofphrase structure accepted and compressed.

The rules of syntax and the predefined vocabulary are given in anappendix, and an example of how to use this vocabulary and these rulesof syntax is presented below. Thus the definition of the product valuegiven in window 48:

Convert=max(convert,Conv_Ratio(dax))

is an assignment of variable using a function whose name is predefined“max”, which is applied to two parameters:

-   -   the first parameter “convert” is a variable;    -   the second parameter “Conv_Ratio(dax)” makes use of a definition        (of the macro function type) given in windows 38 and 39, which        means that the expression “Conv_Ratio(dax)” should be replaced        by the expression “100*dax/ConvPrice”, in which “dax” is a        variable and “ConvPrice” is an expression that should in turn be        replaced by the numerical value “6500”, because of the        definition given it in windows 36 and 37.

The definition of window 48 uses a reserved vocabulary word “max”,defined as being a function name. The set of reserved function names isdefined in the grammar as follows:

$\begin{matrix}{{FUNCTION\_ NAME} =} & {``{CONT}"} \\\; & \left| {``{MAX}"} \right. \\\; & \left| {``{MIN}"} \right. \\\; & \left| {``{MAXINDEX}"} \right. \\\; & \left| {``{MININDEX}"} \right. \\\; & \left| {``{SQRT}"} \right. \\\; & \left| {``{LOG}"} \right. \\\; & \left| {``{EXP}"} \right. \\\; & \left| {``{MIN}"} \right. \\\; & \left| {``{ABS}"} \right. \\\; & \left| {``{INT}"} \right. \\\; & \left| {``{TERM}"} \right. \\\; & \left| {``{SPOT}"} \right. \\\; & \left| {``{FX}"} \right. \\\; & \left| {``{DF}"} \right. \\\; & \left| {``{LIBOR}"} \right. \\\; & \left| {``{SWAPRATE}"} \right. \\\; & \left| {``{LEVEL}"} \right. \\\; & \left| {``{ACCRUEDCOUPON}"} \right. \\\; & \left| {``{ACCRUALFACTOR}"} \right. \\\; & \left| {``{BLACKSCHOLES}"} \right. \\\; & \left| \left( {{``{FIX\_ DATE}"}\mspace{20mu} {``{FIXDATE}"}} \right) \right. \\\; & \left| \left( {{``{START\_ PERIOD}"}\mspace{14mu} {``{STARTPERIOD}"}} \right) \right. \\\; & \left| \left( {{``{END\_ PERIOD}"}\mspace{14mu} {``{ENDPERIOD}"}} \right) \right. \\\; & \left| \left( {{``{PAY\_ DATE}"}\mspace{14mu} {``{PAYDATE}"}} \right) \right. \\\; & \left| {``{CGV}"} \right. \\\; & \left| {``{START}"} \right. \\\; & \left| {``{END}"} \right. \\\; & \left| {``{NOW}"} \right.\end{matrix}$

The definition of window 48 also uses the following rules of syntax:

-   -   definition of an assignment:        -   assignment=ID “=” expression;    -   definition of a function:        -   function=(FUNCTION_NAME|auxTab_or_array) “(” exprList “)”;    -   definition of a list of expressions:        -   exprList=expression {“,” expression};    -   definition of an expression:        -   expression=sum;        -   sum=product {(“+”|“−”) product};        -   product=power {(“*”|“/”) power};            -   power=sign {“̂” sign};            -   sign={“+”|“−”} atom;        -   atom=function|ID numconst “(” expression “)”.

It is evident that the definition of an expression is given by rulessuccessively dependent on each other and using the definition of afunction for the last one. It is therefore possible in any expression tomake use of a function that itself uses expressions, which also usefunctions, and so on recursively.

1. Financial product pricing system consisting of interface means, datastorage means, calculation means, and data processing means,characterized in that: (a) the interface means consist of means forinputting data that identify and describe the product into the system,whereby these data consist of: (a1) contextual data of the product,consisting of at least one valuation currency and at least oneunderlying instrument, (a2) characteristic data of the product,consisting of a set of events and flows associated with the product; (b)the data processing means consist of means for generating a plannedschedule (T1) from the identification and description data, in which anevent and/or flow relating to the product is associated with each date;(c) the data processing means also include means for interpreting theschedule, in order to generate: (c1) a table of variables (T3) for theproduct on the basis of the events and/or flows, (c2) for each date ofthe planned schedule, a function for calculating the product price as afunction of at least one of the product variables; (d) the interfacemeans consist of means for inputting a list of market variables (T4)associated with the product and generated by a market analysis; and (e)the calculation means consist of means for calculating, for each of themarket scenarios/states and for each of the dates, the product variablevalues according to the market variables, and means for calculating theproduct price as a function of the calculated product variable values.2. System according to claim 1, characterized in that the dataprocessing means consist of means for generating a compact scriptcontaining all the data needed for product pricing.
 3. System accordingto claim 2, characterized in that the means for inputting dataidentifying and describing the product consist of means for inputtingthese data in compact script form.
 4. System according to claim 1,characterized in that the means for inputting data identifying anddescribing the product consist of acquisition windows, into which thecontextual data and characteristic data can be entered separately. 5.System according to claim 1, characterized in that the data processingmeans also include means for checking the interpretation of theschedule.
 6. System according to claim 1, characterized in that thecalculation means consist of: (e1) means for calculating, for each ofthe market scenarios/states and for each of the dates, the value of eachof the market variables, (e2) means for calculating, for each of themarket scenarios/states and for each of the dates, the product variablevalues as a function of the market variable values, (e3) means forcalculating the price as a function of the product variable values inall the market scenarios/states.
 7. Financial product pricing systemaccording to claim 6, characterized in that the data storage meansconsist of means for storing the market variable values in the form oftables (Tvvm).
 8. Financial product pricing system according to claim 1,characterized in that the data storage means consist of means forstoring, in the form of tables, the schedule (T1), the calculationfunctions (T2), the product variables (T3), the market variables (T4),and the product variable values (Tvp).